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At Mullooly Asset Management, we help a lot of individuals manage their retirement accounts at work. The type of retirement account doesn’t matter (401k, 403b, or 457), we advise individuals on how to allocate their retirement savings within these plans. Sometimes, we review a client’s employer sponsored plan and it seems to be lagging the other investment accounts they have with us. Not shockingly, these clients tend to ask us what’s going on.
A topic that we discuss with clients frequently is how the structure of their employer’s plan can affect investment returns. We’ve seen some excellent retirement plans and some that could use a little work. From a cost standpoint, one of the least friendly retirement plan structures we’ve seen is the group annuity inside a 401k or 403b. Unfortunately, many people whose retirement plans fall into this category aren’t even aware of the additional fees they’re paying.
I recently reviewed the investment options within a new 401k account we’re managing for a client. I was surprised and disappointed to find that ALL of the mutual funds offered through this plan had expense ratios greater than 1%. Some of the funds were proprietary offerings, but a few other fund families were represented as well. Even the Vanguard funds had expense ratios over 1%!
Why the high fees, you ask? With a little more digging, I realized that this 401k plan is actually a group variable annuity product within a 401k. This structure is also very common in 403b accounts. In group annuity products, mutual funds carry additional expenses that go towards the product’s insurance aspects. Sometimes people forget, but annuities are insurance products after all. These costs go to cover things like mortality expenses, sales loads, revenue sharing agreements and much more. Group annuity policies make for an expensive way to invest.
Any time you decide to invest within an insurance wrapper (through universal life insurance or a variable annuity, etc.), the additional fees are going to place a drag on your returns. For example: You invest in mutual fund X within your IRA, it has an expense ratio of .11%. You invest the same amount of money into mutual fund X within a group annuity policy in your 401k, it has an expense ratio of 1.11%. Which investment will earn more over time? You guessed it, the mutual fund without the additional 1% in expenses. The cost of investing within an insurance product over time eats away returns.
An issue I have with group annuity policies is that, often participants have no choice. If an individual decides to invest through an insurance product, and understands the costs of doing so, but wants the contractual guarantees: that’s fine! Different strategies are going to be appropriate for different investors. However, employees of companies that offer their retirement plan in the group annuity format don’t get a choice. Here’s your way to save tax-deferred for retirement, oh yeah and it’s an annuity. That might be alright for some, but probably not for all. In my opinion, it’s an expensive way to do things.
Insurance products are good at being insurance products, however when they attempt to double as investment vehicles, I believe their benefits are questionable at best.